The Week Explained: Polls and Share Prices

Demoralised Republicans had one piece of good news as results poured in confirming a second term in office for US President Barack Obama. They said before the election that a win for Obama would be bad for the stock market and, indeed, share prices tumbled, sending the S&P 500 index below the 13,000 mark. The market then perked up, but has slumped again.

In other words, the market has been performing true to form, according to research from the Bespoke Investment Group showing that, on average, a Democratic win in the White House sends shares down 1 per cent immediately after an election, while a Republican win has the market rising by 4 per cent.

However, Republicans should be cautious in repeating the myth that a Democratic president is bad for stock markets. The opposite is true, according to the Stock Trader's Almanac's finding that, since 1945, markets have performed far better under the watch of Democratic presidents than under their Republican counterparts.

Obama's first term in office confirms the pattern. Since January 2009, shareholders in American stocks have seen the average value of their portfolios rise by 92 per cent, including dividends, equivalent to an annual return of 19 per cent.

However, it seems that the political complexion of the White House is far less important in determining the behaviour of the stock market than the apolitical way in which the election cycles move markets.

History records that the market's immediate response to a win by a presidential challenger is more positive than when an incumbent is re-elected. In the 60 days following five previous close elections a win for the challenger produced a 6 per cent rise in share prices, whereas victory for the incumbent produced a more anaemic rise of 2 per cent.

Even more consistent is a pattern noted by US-based Ned Davis Research showing that, since 1900, shares posted their weakest returns in the first year of the four-year election cycle, averaging out at 3.4 per cent, rising to 4 per cent in the second year and moving to an average of 11.3 per cent in the pre-election year before slipping back to a 9.5 per cent gain in election year.

This pattern, however, has not held good for the past two presidential terms. In George W. Bush's second term of office, markets performed reasonably in the first two years, followed by a rise of just 5 per cent in 2007, giving way to an enormous plunge of 37 per cent in 2008 - the year of a very damaging recession.

President Obama's first term also departed from the pattern, but in a more positive way, as the market soared 26 per cent in his first year in office, rose again by some 15 per cent in the second year, but this year is showing a more moderate rise of some 8 per cent to date.

The incumbent of the White House has considerable power, but what moves markets largely happens outside Washington. Moreover, what seems to exercise an even bigger sway over how markets behave are cycles that keep repeating themselves. On this basis investors might consider avoiding equity markets in the first two years of a presidential term but should get back in for the third year when markets typically perform best, and even fourth year returns have been healthy in election years.

All of this runs contrary to the often stated view that investors value stability and predictability above all else. Not true. What investors really like is change, giving rise to new opportunities. Thus they will pour money into markets on the cusp of an election, but are less inclined to invest once the results are known.

In Hong Kong, local share prices are hugely influenced by Wall Street, but investors barely blink during local elections, as the government always wins.